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Short Interest

Short Interest
Short selling allows us to profit from a falling stock or market.  There are brokerage departments whose sole purpose is to research deteriorating companies that are prime shortselling candidates looking for weaknesses that the market may not have discounted yet. They will also look for what is called the short interest.  We should be looking at short interest also.  The short interest can serve as a marketsentiment indicator and we need to be aware of it.  Short interest is the total number of shares that have been sold short by investors that have not yet covered or closed out their position. For example a stock with 1.5 million shares sold short and 10 million shares outstanding has a short interest of 15%.  A large increase or decrease in a stock's short interest from the previous month is a telling indicator of investor sentiment.  When TASR short interest increased by 10% in one month that should have been a warning sign that the stock was eventually going to go lower. 

A high shortinterest stock should be approached with caution if you plan on going long.  This is because short selling is done mostly by professionals not the average investor and professionals are right most of the time.  So if the smart money thinks that the stock is going down you may want to think twice about going against their trade.  However some investors use the contrarian approach and use short interest as a tool to determine a possible reversal to the upside. The rationale is that if everyone is shorting then at some point they will have to buy to cover and the stock will eventually have buying pressure.  In my opinion this is a mistake because if the majority of the short sellers are professional; they will organize a smooth orderly covering process that will not take the stock up.  They can control this process and believe me they do.  It is a coordinated effort by the big brokerages houses to prevent a short squeeze. 

ShortInterest Ratio
The shortinterest ratio is the number of shares sold short divided by average daily volume. This is called the daystocover.  Given the stock's average trading volume it tells us how many days it will take short sellers to cover their positions.  For example if a stock has short interest of 5 million shares while the average daily volume of shares traded is 5 million the calculation concludes that it would only take 1 day for all of the short sellers to cover their positions.  The higher the ratio the longer it will take to buy back the borrowed shares.  If the days to cover stretch out 4 and 5 days or more covering a short position could be difficult.  These high ratio shortinterest stocks usually turn into major short squeezes if good news is released and that can become very painful.  

The NYSE ShortInterest Ratio
The NYSE shortinterest ratio is another metric used to determine the sentiment of the overall market. The NYSE shortinterest ratio is calculated monthly and includes all short interest on the entire exchange divided by the average daily volume of the NYSE for the month.  For example if there are 5 billion shares sold short in April and the average daily volume on the NYSE for the same period is 1billion shares per day the shortinterest ratio is 5. This means that on average it will take five days to cover the entire short position on the NYSE. In theory a higher NYSE shortinterest ratio indicates a more bearish market outlook. However the contrarian in this case would be very bullish. 

The Indicator
Here is the secret to calling a market bottom in my opinion.  When the professionals (fund managers specialist floor traders etc) have covered all of their shorts in an orderly manner while keeping market sentiment bearish enough to get the public interested in shorting you can bet that the market is about to reverse to the upside.  The professionals are not wrong mean while the public is almost always wrong.  If you know how much of the short interest is professional and how much is public you can conclude with a reasonable guess if we are near a bottom.  I am interested in the specialist to public short ratio but do not know where to find it or even if it is available publicly.  I will continue to research and try to find this information.  Armed with this golden information I am confident that we can predict with accuracy when the market will bottom.

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